Andy Su
So when deciding to buy, take your time — don’t rush. Most homes are much cheaper than they were a few years ago and will probably stay that way for a while.
First, decide if you are financially ready to purchase a home. Do you have a steady income, a 20 percent to 25 percent down payment saved up, good credit and minimal debt?
Of course, just because you can afford a home doesn’t mean that you should purchase one.
Consider, do you plan on staying in the area for more than five to 10 years? If not, buying a home may not be the best financial choice at this time.
If you are financially ready, don’t over-buy. Your overall debt after the purchase (mortgage plus other debts) should be less than four times your annual income. For example, if you have an annual income of $80,000, $75,000 in savings, $20,000 in student loans and credit card loans, then $375,000 is the most you should spend on a home ($300,000 in mortgage after a $75,000 down payment).
There are only two types of mortgages out there that you should consider: a 15-year fixed and 30-year fixed. For more detailed information on purchasing a home, I recommend a book called “Home Buying for Dummies” by Tyson and Brown.
After the plunge
Now that you have purchased a home and still have money to invest, you might ask yourself if you should invest in rental properties? To do this, you should have a large cash reserve, a stable income and some knowledge about the rental market before you even think about purchasing a rental property. Even when you can afford to purchase an investment property and have the knowledge, it doesn’t mean you should.
Historically, rental properties have produced very modest returns, but those returns are still generally lower than the returns of stock/mutual fund investments, even when tax savings are included.
Also, being a landlord is not for everyone. Using a property manager is a possibility, but that will reduce your overall returns. If you do decide to purchase a rental property, make sure you can be cash-flow positive (the rent charged minus expenses should be positive) or close to it.
And, very importantly, do not overpay for the property.
• Andy Su, MD is an emergency physician who works full-time at the Sutter Tracy Community Hospital Emergency Department and a Board Member of the Tracy Hospital Foundation.
Thank you for your comments.
I agree with you that the $375,000 house would cause someone with an $80,000 annual income to be overextended but I didn't really recommend buying the biggest house one can afford. I actually started the paragraph by saying don't overbuy.
Let me correct the numbers in my example and explain things better.
First, before buying a house, you need to have a 6-12 month worth of living expenses in an emergency fund like we discussed previously.
Second, you are correct, if I had $75,000 in the bank and $20,000 in credit debt, student loans and car loans, I would probably pay the debt off first.
Next, with the $55,000 left, you really only have enough for a 20% down payment on a $275,000 house.
Your monthly payment for a $220,000 mortgage at 6% (30 years) is around $1300. If you add $300 a month for property taxes and insurance, your overall monthly debt becomes $1600. With your $6600 monthly income, that gives you a very reasonable debt to income ratio of 24%.
Andy Su
Using the numbers given above if you have $75,000 in the bank why would you not pay off the $20,000 in student loans and credit card loans before making a home purchase? This would reduce your overall debt significantly. You also do not take into consideration auto loans which apply toward the 36% debt to income ratio. Based on the numbers you provided a person would be overextending themselves each month.
All of the debt to income ratio and home affordability calculators I looked up online divide annual income by 12 to get a monthly figure.